Could a rate rise be on the cards?

Since the Brexit vote, it feels as though things have moved along at a rate of knots within both political and economic spectra. Certainly on Threadneedle Street, it’s been a rather hectic period, with Bank of England Governor Mark Carney spending a lot of time in the headlines.

Carney attracted criticism for his ‘interventions’ during the build-up to the EU Referendum, but it is to his great credit that he has acted decisively since. Indeed, it was the very next day that he announced that £250 billion worth of funds had been made available to the economy in order to maintain stability.

It was of course the Monetary Policy Committee’s decision to cut base rates in August – a continuation of Carney’s so-called ‘quantitative easing’ - which has divided opinion. Many economists argue that this has given the economy the necessary impetus to handle the turmoil following the referendum, and that it has played a key role in most sectors of the economy performing better than expected.

However, it arguably also contributed to the decline of the pound, and has unquestionably had an adverse effect on savers. Such criticism reached fever pitch in the wake of the Conservative Party Conference last month, where the Prime Minister expressed dissatisfaction at the policy of quantitative easing itself.

It meant that speculation over the Bank of England’s future independence became rife, with Carney considering his position over the past week. The Canadian has, however, committed to staying until 2019, and it comes at a time where news for the economy has once again been more positive than expected.

Positive signs

Growth, albeit propelled by the performance of the services sector, exceed all expectations in the third quarter of 2016 – the 0.5 per cent figure making ours the best-performing major economy in the world in that time. Prior forecasts of a recession appear to have dissipated, and Carney now forecasts growth of 1.4 per cent in 2017. Although this would fall below the corresponding forecasts for inflation (adjusted upwards to 2.7 per cent this week), it makes for considerably better reading than the gloomy forecasts which have preceded it.

Such was the air of confidence within the Monetary Policy Committee as a result that it is understood the vote to hold base rates steady at 0.25 per cent on Thursday was unanimous – a significant revelation given previous talk of further cuts. And inevitably, it has sparked suggestion that Britain may well be in for an increase in rates in the near future; one which would represent the first since July 2007.

A boost for savers, curb to inflation

Given the unrelenting strain savers have endured in recent years, it would be difficult to begrudge them the respite of an increase in rates. In early November 2007, base rates were at the heady heights of 5.75 per cent, but the subsequent and sustained plunge to record lows has severely hit savers and pensioners in the pocket. A rates increase would thus go a long way to turning the tide.

Additionally, such an increase would help to curb the escalating figures for inflation; largely for two reasons. Firstly, microeconomic law dictates that interest rates and inflation have an inverse relationship anyway. However, a rates increase would also likely provide some much-needed forward thrust for the sterling. Again, other things equal, such a decision would make foreign investment more attractive, with subsequent inflows of capital strengthening the value of the currency. For an import-heavy economy such as the UK’s, this would no doubt help to halt rising prices across the board.

Cautious optimism

As with anything in economics, policy changes can be a double-edged sword, and be beneficial for some while being negative for others. For a country with household debt (excluding mortgages) in excess of £350 billion, such a rates increase would put strain on many consumers. Added to that, increased interest rates, and a more contractionary monetary policy, will almost certainly suppress consumption, with reduced spending then providing a headwind of its own for economic growth.

But what seems to be increasingly clear is that the economy is fundamentally stronger than many had previously thought. Frustratingly, economic performance can only be determined, and then analysed, in hindsight, and with forecasts seemingly becoming less and less reliable by the day, predicting the future is an unenviable task for Carney and Co.

Yet there are so many indicators which suggest that our economy is in a decent state of health - certainly healthy enough to withstand the impact of a rise in base rates. So could such a day be on the horizon? Long-suffering savers will certainly hope so.

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Michael Todt

Mike joined Lending Works in early 2015 with a background in marketing and journalism. Having long held a passion for economics, he is now the chief contributor to the Lending Works blog, and regularly writes about all things peer-to-peer lending, fintech and personal finance.